I often get asked “how do I pay my kids from my business?” What people are really asking with this questions is “how can I go about paying kids to save taxes?” So, I’d like to shed some light on an innovative strategy that will have you reaping the benefits come tax time. In particular, I’ve found this to be a beneficial strategy for medical professionals in the healthcare field, although other business owners can definitely benefit. So, let’s dive into the world of “income splitting” and discover how what I call a Bow Tie Trust can be your ultimate weapon to maximize tax savings while securing your family’s financial future. Brace yourselves. This is going to be a game-changer!
Video Transcript: Paying kids to save taxes
Common question I receive, can I save taxes by paying my kids?
I’m George Dube, saving the world from tax, one bow tie at a time.
The answer? Yes, if done properly. But it’s not so simple.
The Bow Tie Trust – The solution for paying minor children
So I want to save money by paying my kids. How can I do that? Let me introduce to you what I’m going to call a Bow Tie Trust.
Others may call it a TOSI trust. TOSI standing for tax on split income. And I think we can all agree the Bow Tie Trust sounds much better.
Who you can split income with to save taxes?
Now, this isn’t actually just for splitting income with minor children. This actually works as well, for example, with kids that are going through post-secondary education. This works well with a spouse that may not be involved with the business. This works well, in addition, to elderly parents.
Tax on split income rules explained
Several years ago the government put in place some rules that really upset many business owners and investors called TOSI rules – tax on split income. And effectively, without getting into all the details, Revenue Canada is essentially taking the position that we have significant restrictions in terms of paying income, and thus saving taxes, when we involve people or pay people that are either too young, or not directly involved in the business.
Exception to TOSI: Bow Tie Trust
There is an exception.
And that’s what the Bow Tie Trust helps to get around.
Let’s talk some more details to see whether you and your family can take advantage of this planning.
Income splitting is something, probably more so accountants like the term, the idea of spreading the families income amongst the entire family. The purpose is that if, for example, a family made $200,000, and it’s a family of four. If we’re able to spread that income amongst 4 family members, their taxes will be significantly lower than the taxes, as if we had to put that entire $200,000 on one person’s tax return.
The Bow Tie Trust allows us to recapture, if you will, some of the glory days when we could do our income splitting. It’s not perfect. But it’s much better than most alternatives.
Alternatives to income splitting
Before we were using Bow Tie Trusts, or rather trying to find ways of income splitting. We could certainly have, and there are alternatives.
Gifting money: Another way to pay kids to save taxes?
One, for example, is simply gifting money to a family member.
But we have problems with that. From a tax perspective, there may be, depending on the family members involved and the nature of the income that is generated, attribution rules which apply. Attribution rules in English means that that income can, at least in part, be attributed back to the person that gifted the funds.
Prescribed rate loans: Can you pay kids this way to save taxes?
In a similar fashion, we may do what’s called a prescribed rate loan. And that allows a higher income individual to loan money to:
- another family member, or
- to a corporation, or other entity.
They have to charge, as you can tell from the name, a prescribed rate of interest, which is determined by Revenue Canada on a quarterly basis. Although it can be locked in. With the prescribed rate loan, we’re still potentially subject, in certain situations, to that income attribution.
The Bow Tie Trust, however, helps get rid of, or mitigate, another screaming problem with using a gift or a loan. That gift or alone from many parents absolutely is fearful because they envision a Corvette sitting in the driveway the next day. The Bow Tie Trust allows mom and dad to control the assets and the income, helping ensure mom and dad’s wishes are met while tax savings are able to be realized. A huge benefit most parents are going to sign up for.
Tax savings with paying your kids using a Bow Tie Trust
Let’s talk about the tax savings available with that Bow Tie Trust.
As an example, if someone was, or has, no other source of income for the year. And I’m referring to, let’s say, a 5-year-old. Mom or Dad, they’re a healthcare practitioner, probably have a professional company. And they have a fair bit of income, as they invest in both traditional and perhaps some non-traditional investments or alternative investments, that many of our clients get involved with. If that income stayed at a corporate level, or alternatively, often using an investment holding company. If that income were to go to a high-income earner, the tax savings on, for example, an eligible $50,000 dividend, would be approximately $20,000 per year. Ratchet that up a touch. If it’s $100,000, the savings approximately $30,000 a year. And that savings, it’s per individual, per year. So those savings can certainly escalate over time.
Disadvantages of a Bow Tie Trust
The Bow Tie Trust, again with a lot of rainbows and lollipops, it does have the same 3 disadvantages that a traditional family trust has.
- Namely, it costs a little bit more to set up.
- It’s not the simplest of things to set up. In other words, it’s a little bit of a pain in the rear end.
Takes some time to do that.
- And the third disadvantage is that every 21 years, we have to re-kickstart that trust.
I’ve described in the traditional Family Trusts set of videos these points. Feel free to go over and check them out in more detail.
Thanks for listening to our Bow Tie Trust discussion. Please again subscribe. There will be updates as time progresses and whether on this or other topics that will help you grow your legacy, grow your assets, and protect them. Please feel free to reach out. Contact me using the details below.
Let’s have a conversation to see how the Bow Tie Trust may fit into your family situation. Have more questions.
Please subscribe, follow, and even share. I want all of us to have the tax information we need to do wonderful things.
-End transcript-
Resources
For additional resources related to family trusts for medical professionals, see:
More questions on paying kids to save taxes?
Still have questions? I want to help you Do Wonderful Things™, so please contact me today.
Remember – circumstances are unique! This information is summary in nature. Seek out advice from your tax advisor about your specific situation.
